The Adverse Selection Problem - Coursework Example

The moral hazard problem occurred as a result of asymmetric information after the transaction happens and prompts a dispute of interests. It is the hazard that a borrower in a monetary contract has the motivating forces to participate in hazardous activities that are making it more difficult that the loan amount will be paid back. On the off chance that there is no asymmetry in the data that a lender and a borrower had, which implies the lender can keep enlightened about the borrower's whereabouts and screen the borrower to follow the terms of the transaction they agreed upon. There should not have the problem of moral hazard. Yet, as a general rule, if financial intermediaries proceed as a lender, setting up a refined and frequently monitor system for every individual borrower may cause a tremendous cost for financial organizations, or significantly bigger than the loss from the expected default hazard (Dionne and Lasserre).

Moreover, if a monetary organization works as a borrower, the administration can limit the trading on insider trading on the biggest stockholders, yet different representatives in the organizations, for example, directors and senior managers might additionally increase profit from the special data which could influence the offer value when unveiled, and trades generate profit or evade losses before the public be informed of the data. Since these data are internal and confidential, therefore, it is hard for potential investors to get knowledge from this and cannot evade the hazard issue from it. Consequently, the problem will still exist (Dionne and Lasserre).

In 2008, as a financial crisis began to unfold in the United States, the FDIC raised the limit on insured losses to bank depositors from $100,000 per account to $250,000 per account. How would this help stabilize the financial system?
As the 2008 financial crisis occurred due to the failure of financial institutions like Lehman Brothers to pay back their depositors against their mortgages and deposits, therefore, it was the responsibility of FDIC to intervene and increase the limit of insured losses from $100,000 per account to $250, 000 per account which is more than double of the former limit, So that the depositors and general public can feel confident to deposit their money with the financial intermediary. Hence, that was the reason behind this change was to enable the government to ensure people’s deposits to save them from great financial losses, especially when the financial intermediary that is holding these deposits fails due to any reason. This increased the confidence of the financial institutions and the general public in each other and improved and stabilizes the overall financial condition of the country. This also reduced the pressure from the general public on financial intermediaries so that they could effectively settle down the crisis (Cowan and Salotti). Read More